Redwood Trust Inc (RWT) Q2 2021 Earnings Call Transcript

Good afternoon and welcome to the Redwood Trust, Inc. Second Quarter 2021 Financial Results Conference Call. Today’s conference is being recorded. I will now turn the call over to Lisa Hartman, Redwood’s Senior Vice President of Investor Relations. Please go ahead.

Thank you. Hello, everyone, and thank you for joining us. With me on today’s call are Chris Abate, Redwood’s Chief Executive Officer; Dash Robinson, Redwood’s President; and Brooke Carillo, Redwood’s Chief Financial Officer. Before we begin, I want to remind you that certain statements made during management’s presentation with respect to future financial or business performance may constitute forward-looking statements. Forward-looking statements are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual results to differ materially. We encourage you to read the company’s annual report on Form 10-K, which provides a description of some of the factors that could have a material impact on the company’s performance and could cause actual results to differ from those that may be expressed in forward-looking statements. On this call, we may also refer to both GAAP and non-GAAP financial measures. The non-GAAP financial measures provided should not be utilized in isolation or considered as a substitute for measures of financial performance prepared in accordance with GAAP. A reconciliation between GAAP and non-GAAP financial measures is provided in our second quarter Redwood review and investor presentation, both available on our website at redwoodtrust.com. Also note that the content of this conference call contains time-sensitive information that is accurate only as of today. The company does not intend and undertakes no obligation to update this information to reflect subsequent events or circumstances. Finally, today’s call is being recorded and will be available on the company’s website later today. I will now turn the call over to Chris Abate, Redwood’s Chief Executive Officer, for opening remarks.

Thank you, Lisa, and good afternoon everyone. We are closely monitoring the latest Delta variant of the coronavirus. The entire organization has been energized to see the reopening of the economy, continued strength in the housing market and exceptional performance and growth in our business. Strong operating income and rising portfolio valuations drove exceptional financial results for the second quarter, including GAAP earnings of $0.66 per diluted share, well in excess of our $0.18 per share dividend for the second quarter. This contributed to a 6.5% increase in our GAAP book value to $11.46 per share at June 30. The results we generated thus far in 2021 are reflective of a business that can expand profitably while successfully serving its mission of making quality housing accessible to all American households. As you know, this mission emphasizes borrowers whose needs are not well served by government loan programs or potentially not at all. Our residential and business purpose lending teams together target the non-agency mortgage market, a segment of the market that many have recently ignored in large part due to the absence of Federal Reserve stimulus. The non-agency market represents the residential mortgage universe outside of government-backed mortgage programs. By targeting this market, rather than a specific borrower profile as we had in the past, our business is not tied to the direction of the homeownership rate. Instead, Redwood now offers a comprehensive product mix that serves both non-agency consumers and housing investors alike and it’s a big market. Many have forecasted residential non-agency origination volumes to significantly increase in 2021 from the $435 billion of originations in 2020. That’s only beginning to reflect the potential from a regulatory pullback for non-owner occupied loans, something that could provide a significant tailwind to our sector going forward. Our results remained strong in the second quarter despite market conditions that were significantly more challenging than they were in the first quarter. Rising interest rates reemerged in the residential lending space, largely the result of uncertainty and whether the Fed will alter its support for the agency mortgage market. The sharp competitive forces that arose as a result, along with a corresponding decline in refinance activity, triggered a contraction in margins across the industry. Exaggerating the effects of strong competition were signs of pro-cyclical and supply chain inflation, with a shifting yield curve driving significant hedging and execution costs for those managing large mortgage pipelines, including for us. Against this backdrop, in the second quarter, we still locked close to $4 billion of jumbo loans at margins in the high-end of our historical target range. The business purpose lending market also became more crowded in the second quarter, with new competitors using the rate sheet to buy their way into the space, particularly for lower balance bridge and rental loan products. The shift out of apartment living and towards single-family detached homes is a trend that has shown no sign of ebbing despite the recent reopening of most major metros. This has led to a shortage of high-quality homes, with aggressive demand from both investors and consumers alike. In many regions, rent growth has been significantly outstripped by home price appreciation, highlighting the scarcity value of quality housing and the multiple constituencies focused on acquiring single-family homes. Leveraging a well-earned reputation as a nimble and reliable lifecycle lender, CoreVest, our business purpose lending platform, eclipsed $500 million of fundings for the quarter and achieved a strong balance of single-family rental and bridge originations. Our sustained performance through this challenging backdrop showcased our strategic foundation and is the essence of what makes Redwood unique. Our mortgage banking businesses offer highly complementary products that drive durable earnings streams. And our investment portfolio continues to offer significant upside as the economy recovers. Our credit discipline and ability to create our own assets remain key differentiators. Our strategic foundation has facilitated returns that are significantly outpacing our growing dividends. In the first half of 2021, approximately 70% of Redwood’s adjusted revenue was driven by our mortgage banking operations, with the remaining 30% from our investment portfolio. We expect mortgage banking, and by extension, our taxable subsidiaries, to continue to be a strong earnings driver going forward. The revenue generated through mortgage banking is nearly double the percentage contribution of recent years and highlights the ongoing shift in our business model as we adapt to changing market conditions. It also supports continued expansion of book value over time, to retain earnings acting as a zero cost avenue for capital formation that has reduced our marginal need for funding and stands in contrast to others in the space that manage their balance sheets. By continuing to reinvest in our infrastructure, both organically and through partnerships, our path to realizing transformative scale is clear. Across our enterprise, we have cultivated a talented and inspired workforce. We have embraced technology to serve our customers more quickly than ever before. One great example of this approach is last quarter’s launch of our early stage investment platform, RWT Horizons. This is something Dash will touch on in more detail. As we look ahead, we continue to raise our game, invest in our people and infrastructure and attack our markets with a service standard that continues to separate us from our competition. We are excited by recent changes in the regulatory landscape that have made the non-agency mortgage market more relevant than it’s been in many years. Our goal is to build a business that serves an important public mission and scale profitably and generate a very attractive return profile for our shareholders. And with that, I will turn the call over to Dash Robinson, Redwood’s President, to discuss our operating results.

Thank you, Chris. Our second quarter results reflect continued strategic progress and strong operating momentum. While our comprehensive non-agency market footprint benefited from ongoing strength in the housing and credit markets, we coupled these macro tailwinds with homegrown ingredients both new and familiar. Our team’s usual crisp execution was complemented by meaningful progress with our technology infrastructure, both organic and through new partnerships already bearing fruit. In sum, the final product was another quarter of significant outperformance. As Chris referenced, benchmark rates remain an area of acute focus for the markets. The uptick in rates during the second quarter has almost fully retraced. The level of uncertainty around the level of government support for agency mortgages may very well moderate the amount of borrower refinance activity we typically see in this kind of rally. Against this backdrop, it’s important to unpack the key drivers of profitability across our platforms. As Chris noted, the markets we serve continue to grow as the path of home prices, evolution and consumer demand for housing and important regulatory trends are driving an expansion of non-agency’s true potential footprint. And while we are not immune from moves in MBS prices versus benchmark rates, our diverse distribution channels and unique product mix allow us to benefit from different drivers of demand. Case in point, while margins compressed elsewhere in the market during the second quarter, we enjoyed durability in our margins with sustained strength and volume across both residential and business purpose lending. In fact, an ebbing demand for agency mortgages represents another potential tailwind for our business. Mortgage originators are still ramping up capacity to address the pent-up demand from jumbo borrowers and as home price appreciation has increased nationwide, along with consumer preference for single-family detached rental housing. Our suite of BPL offerings remains in high demand and our residential business’ geographic footprint continues to expand. Homeowner equity is now at its highest levels in at least a decade, pushing more loan demand above the conforming loan limits and into Redwood’s addressable market. As we note in our updated investor supplement, there are now 13 states in which we have locked more loans year-to-date than in each of the two years prior to the pandemic. Collectively, locks in these states represent 35% of our year-to-date volume, a trend we continue to track with great interest. Overall, market observers now forecast single-family home price appreciation for 2021 to be 14% and 16% for existing and new homes respectively. Even if this moderates as expected into 2022, we expect the trend to continue of more locations across the country evolving into non-agency markets. Another key driver is the regulatory environment. The evolving rules are likely to meaningfully increase the qualified mortgage or QM cohort, a significant boon for high-quality expanded credit borrowers. Furthermore, caps in place since earlier this year on GSE purchases of non-owner occupied loans could expand the non-agency market by an estimated $25 billion to $35 billion per year. And there is likely more the non-agency market can do to help address broader access to credit and the associated impact on first time homebuyers and low to moderate income borrowers overall. Also critical to the equation is the availability of high-quality rental housing, including single-family detached, an issue solved in part by an increase in custom-built projects. As we discussed on prior calls, housing supply has not kept up with demand and building material costs, though moderating, remain high, contributing to significant price escalation on homes. Single-family homes for rent can meet the demand for expanded space in desirable neighborhoods and a monthly payment that more consumers can afford. Reflecting these supply-demand dynamics, single-family rental occupancy rates remain at record highs, with a weighted average of 95% for all U.S. single-family rental homes. And single-family rents have remained meaningfully more buoyant than multifamily rents since early last year. Our second quarter results reinforced this broader backdrop. Operating highlights for the quarter include reaching our second highest level of jumbo locks ever and our highest BPL volume since late 2019. As Brooke will elaborate on, book value increased 6.5%, driven by a mix of asset appreciation through fair value changes and retained earnings from mortgage banking income earned at our taxable REIT subsidiary. Collectively, our platform distributed $3.6 billion of loans through direct loan sales and four securitizations. Following the historic first quarter, our residential business registered $3.9 billion of lock volume in Q2. As anticipated, purchase money loans were a key driver and represented a 60% share of the quarter’s lock volume. Despite the interest rate backdrop and competitive pressures impacting GSE-eligible production, the business delivered margins at the high-end of our historical target range of 75 to 100 basis points, reflecting the diversity of our distribution channels and strength of our pipeline management amidst broader market volatility. During the second quarter, we sold $1.8 billion of loans and completed three Sequoia securitizations for $1.5 billion. While we saw moves in rates during the quarter and a dramatic flattening of the yield curve after the June Fed meeting, the end-to-end coordination and efficiency with which our teams function remain a true competitive advantage. The flexibility of our securitization program, coupled with whole loan distribution, facilitates further scale as collectively they allow us to be in the market consistently. During the second quarter, we were once again faster to market than the competition in distributing our pipeline. Another encouraging metric was the contribution that Redwood Choice, our expanded prime product, made to volumes. Choice represented 15% of our locks in the second quarter, up materially from 5% in Q1. Choice represented as much as 40% of our locks pre-pandemic, a reminder of how meaningful this channel can be. In recent public remarks, we continue to emphasize changes to the QM rules that we believe will be a key tailwind to Choice’s reemergence. If adopted safely, the new rules focused on mortgage rate as a determinant of QM status will allow another sleeve of high-quality borrowers to qualify more easily for competitive rates, an important step that underscores the true potential of the non-agency market to serve a deeper bench of consumers. We are actively engaging with our seller base to bring this to fruition. These macro trends also reflect meaningful tailwinds for CoreVest, our business purpose lending platform. The second quarter was particularly productive in BPL as we advanced several key initiatives, most notably completing our strategic investment in Churchill Finance. CoreVest originated $527 million overall in the second quarter, up 37% from Q1. Our funding mix consisted of $312 million of single-family rental loans and $215 million of bridge loans. Bridge production was up over 60% from Q1, an increase for the fourth consecutive quarter driven by increased usage by borrowers on lines of credit and several build-for-rent and multifamily loans coming online for funding. The origination mix for BPL in the second quarter reflects the strength of our multi-product strategy, which results in high levels of repeat borrowers, including those that utilize more than one of our loan products. In all, 67% of total originations in the second quarter were from repeat customers and the pipeline remains strong, with a consistent mix of new loans and refinance opportunities. So far, production remains strong in the second quarter, with fundings up 23% from Q1. As we discussed on our last call, the pipeline remains robust and execution has benefited from increasingly constructive securitization markets. We completed our first broadly syndicated CoreVest securitization of the year in April, achieving all-time tights on credit spreads with a deep bench of investors. That record proved short-lived. Last week’s follow-on transaction once again priced at all-time tights, including a spread of 57 basis points on the AAA rated securities. As we have seen many times before, this type of execution inevitably breeds additional competition, which we view as an opportunity for CoreVest to continue differentiating itself as the BPL market’s lender of choice. We have high expectations for our forthcoming refreshed client portal, especially its new user interface, which will make it even easier for our clients to upload documents and track progress of their loans. Additionally, we continue to press our advantage as a nimble lifecycle lender. We are finding product suites to continue serving the end-to-end needs of a deepening cohort of sophisticated housing investors. Highlighting this progress is our partnership with Churchill, which we expect will diversify our sourcing channels with a particular emphasis on smaller balance single-family rental and bridge loans. We have now closed our first purchase of bridge loans and SFR loans from Churchill and see an attractive near-term pipeline to complement our direct lending products. In periods of increased competition, it’s important to reinforce the value of an institutional platform like CoreVest in a market that in many ways is still developing. We have now completed optional calls on two CoreVest securitizations, refinancing many of the underlying loans with a platform made five or more years ago. Many borrowers have now been with the platform for at least that long as CoreVest continues to support their growth and evolution. That sort of track record matters and has immense intangible value on the field of play. Our newest initiative, RWT Horizons, is doing its part and keeping pace with our enterprise-wide progress. Since formally launching Horizons earlier this year, we have completed five investments and are assessing an exciting pipeline of new opportunities. Most recently, our direct investments include Liquid Mortgage, a platform focused on leveraging blockchain technology to bring efficiencies to the non-agency market, and a tech-enabled residential construction management firm. At this early stage, it’s exciting to witness tangible progress with our new partners. Liquid Mortgage recently procured a key patent covering the vast majority of its business plan, a big step in our collective efforts to apply blockchain technology to the non-agency ecosystem. Rent Room and Rent Butter also both had productive quarters and are meeting or exceeding their planned product development and rollout initiatives. Most critically, these partnerships reflect the intellectual collaboration that drives true alpha for all parties involved. We are engaging directly with Liquid Mortgage and developing the work streams required to safely put mortgages on blockchain and together are working to engage other key stakeholders across the industry. For Rent Room and Rent Butter, two investments sourced through CoreVest borrower network, we are facilitating synergies with our broader client base. We are thrilled to be working shoulder to shoulder with those standing on the frontier of innovation in our markets. With that, I will turn the call over to Brooke Carillo, Redwood’s Chief Financial Officer.

Thank you, Dash. As previously noted, our second quarter 2021 results reflect the durability of our model and continued strength across our entire platform. We have reported GAAP book value per share of $11.46 at June 30, a 6.5% increase relative to the prior quarter end. The primary drivers of the $0.70 increase in book value per share were GAAP earnings of $90 million or $0.77 per basic share, partially offset by our quarterly dividend of $0.18 per share. We are pleased to have maintained the strong momentum from the first quarter, generating a total economic return on book value of 19% for the first half of 2021. Our economic return spotlights not only our growth in book value, but also our growth in our dividend which we raised by another 13% in the second quarter. We saw particularly strong results this quarter from our business purpose mortgage banking operations, which delivered a 52% after-tax operating return on capital with the net operating contribution of $20 million, which is up 80% from Q1 on a 37% increase in origination volumes. Income from residential mortgage banking operations decreased from the historic first quarter level, while still delivering an after-tax operating return of 17%. Even as loan purchase commitments were down 22%, Q2 still marks our second highest volume on record. To reiterate Dash’s point, gross margins remained at the high-end of our historical target range despite a challenging macro backdrop that impacted securitization execution and increased hedging costs relative to the first quarter. Turning to the investment portfolio, we had $49 million of positive investment fair value changes primarily from our RPL assets, given further spread tightening and improved credit performance this quarter which I will expand upon shortly. Net interest income increased approximately 20% or nearly $5 million from the first quarter of 2021 due to higher average balances of loans and inventory at our operating businesses, higher yield maintenance income from SFR securities, growth in our bridge loan portfolio and a decline in interest expense from our investment portfolio. Shifting to the tax side, we had retaxable income of $0.11 per share versus $0.09 in the first quarter, primarily on higher net interest income. Our taxable REIT subsidiaries earned $0.27 per share in Q2, down from $0.47 in Q1. The decrease was primarily driven by lower mortgage banking income partially offset by lower operating expenses and resulted in a $5 million lower tax provision for the quarter. On a combined basis, our operating businesses generated an annualized after-tax return of over 28% in Q2, utilizing $483 million of average capital. As a reminder, these earnings can either be reinvested back into our operating businesses or paid as a dividend to the REIT. This quarter, we continued our focus on higher margin businesses that produced strategic assets for our investment portfolio. Specifically, we deployed $45 million of capital to bridge loans during the quarter and $50 million to SFR securities and whole loans. Year-to-date we have not reduced the size of our third-party investment portfolio through opportunistic sales. Working capital for our mortgage banking businesses represented less than 30% of our allocated capital, but produced approximately 65% of our adjusted revenue for the second quarter. As Chris mentioned, the proportion of adjusted revenue from our mortgage banking operations has been growing in recent years and has facilitated returns that are significantly outpacing our growing dividends. Total portfolio returns rose by a combination of improved credit and faster prepayment speeds on securities we hold at a discount to face value. Higher prepayment speeds continue to benefit these portfolios and allow us to accelerate our call options within Sequoia and CoreVest securities. We settled the call rights on three Sequoia securitizations and one CoreVest securitization during the second quarter, acquiring $83 million of seasoned jumbo loans and $45 million of seasoned SFR loans all at par, which benefited book value by $0.05 per share. We estimate about $250 million to $300 million of expected call activity across CoreVest and Sequoia through the remainder of the year and we estimate at current market conditions the underlying loans can generally be sold or resecuritized well above their par value creating further potential upside to earnings and book value of approximately $0.68 per share for 2021. Furthermore, we project another $2 billion of loans that could become callable by the end of 2024 with the majority of those currently expected to occur by the end of 2022, and that could potentially add another $0.63 to $0.65 per share on average to book value depending on execution. Net delinquencies in our portfolio continue to improve with new forbearance requests near zero. Specifically, Choice and RPL securities experienced improved 90-day delinquencies during the quarter with select remaining flat from Q1 and absolute low levels of 80 basis points. It’s worth noting the improved delinquency trends with our RPL securities portfolio experiencing 60-day delinquencies now below pre-COVID levels, and voluntary prepayment speeds continue to well exceed our original modeled expectations. LTVs in the portfolio are low and continue to improve or hold stable and average coupons aren’t in excess of our current mortgage rate which should provide options to help distressed borrowers and keep actual losses low. At quarter-end, our balance sheet and funding profile were in excellent shape following several liability and capital management actions taken during the quarter. We added over $750 million of financing capacity to support growth of our operating platforms including the refinance of a $242 million bridge loan financing which contributed to a roughly 100 basis point cost of funds improvement for our overall investment portfolio. Importantly, the second quarter marked another record for Redwood with combined $3.3 billion of residential whole loan sales and securitizations underscoring our ability to source and distribute at scale. Our recourse leverage was marginally higher at 2.2x at the end of the second quarter as we incurred additional warehouse borrowings to finance higher loan inventory. At June 30 our unrestricted cash was $421 million, which is over half the size of our outstanding marginable debt, and at quarter end, our investable capital was $175 million, not including $100 million of incremental capital generated from a secured term financing we closed in early July. I’ll close with an update on our 2021 financial outlook. We continue to see upside potential in our book value from here both from anticipated call activity in our investment portfolio and through our ability to grow and retain earnings at our taxable REIT subsidiary. We encourage you to review the supplemental quarterly materials we published earlier today, which provide more detailed and refreshed guidance for the remainder of the year to highlight some of the key inputs that support our financial narrative. Confidence in our ability to achieve our guidance is grounded in a sustainable trend we’re seeing across our businesses. As Chris and Dash have outlined, the key themes that will drive our performance include increasing our wallet share, using technology to drive efficiency, allocating more capital to our higher ROE operating platforms, continuing to create value through the investment portfolio and using partnerships, M&A and other growth strategies to further efforts in our target markets. As we look ahead, we remain on track to keep pace with the robust volumes we’ve seen through the first half of the year anticipating another $6 to $8 billion of jumbo locks and approximately $1 billion of BPL originations for the second half of the year, which would nearly double the volume of that business year-over-year. For perspective, second half volumes on the residential front approach our full year volume just a couple of years ago. We’ve demonstrated our ability to successfully grow not only our origination volume, but also our market share and we believe we can continue to do that across our platform and in each of the underlying channels. Small changes in market share can have a meaningful impact to our overall profitability and scale and that’s what we’re planning to do over time. For the remainder of the year, we anticipate generating an adjusted return on allocated capital between 20% to 25% from our mortgage banking operations, and 10% to 12% for the investment portfolio. As credit spreads have tightened fairly significantly and fair values have since increased, this forward yield on the investment portfolio, which is in line with our forecast at the beginning of the year, reflects improvements in our financing costs and capital optimization. And finally, in terms of the potential sources and book value upside we began the year with $444 million of net accretable discount in our portfolio, and even after growing book value of $1.55 per share or roughly $175 million since that time we have approximately $2.60 per share or $300 million of remaining discount in the portfolio that we have the potential to recognize over time. With that I’d like to turn it back to the operator to open the call for Q&A.

Thank you. Our first question comes from the line of Stephen Laws with Raymond James. Please proceed with your question.

Hi, good afternoon. Congratulations on a very nice quarter. You guys did a great job of covering the different opportunities for ROE expansion, and Chris, I liked the way you phrased transformative scale that the company is starting to achieve. Dash, if you could run through these, I think you covered a number in your prepared remarks, but when I look at the opportunities for ROE expansion between Rapid Funding, Churchill, Horizons, you’ve talked about Choice going to 15% versus historically 40% of volumes there, and then you do financing facility as well as a lower cost financing facility. What are you most excited about when you think about the ROE expansion opportunities— which one or two do you think will have the biggest impact in maybe the next 12 to 18 months?

It’s a great question, Stephen. Candidly, we are excited about all of them in some fashion. I would probably categorize the near-term opportunities for ROE expansion as our existing businesses at scale realizing operating leverage—both residential and BPL. We’ve seen durability and margin expansion in both of those businesses, more efficiency in our cost to originate and cost to produce, and those are tangible benefits we expect over the next several quarters. Medium to long-term, things like Horizons and Churchill are newer and we expect they will take some time to come online, but we think they will be meaningful contributors. Churchill is a nice complement to what’s already a deep bench of products that we have through CoreVest; it allows us to access parts of the market more cost efficiently than doing it entirely on our own. Horizons is where so much of the alpha lies for our enterprise-wide efforts because at its essence Horizons is trying to link us up with entrepreneurs and others in the market and advance ideas that can revolutionize, rather than just evolve, some of our businesses and how we work. That will take a bit longer to come online and ultimately we expect Horizons not only to produce good investments in their own right, but also to evolve how efficiently we work within our core businesses today.

Great, thanks for the color. Brooke, maybe on the net interest income, it’s a pretty strong quarter. I think I read in the review deck that a lot of that was due to some high loan balances ahead of transactions. How should we think about that moving sequentially? I know there is a securitization just after the end of the quarter—will we see NII pull back a little bit because of that securitization or is the $30 million number kind of a good run rate given the lower financing costs that have been put in place?

There will be a little bit of noise around quarter end depending on inventories, although net interest income was up $5 million quarter-over-quarter. Some of that was driven by our financing cost improvements which you correctly pointed out—we made good advancements this past quarter and refinanced some of our higher cost facilities—coupled with securitization execution, which continues to be strong, especially on the BPL side. I think we continue to see room to further support net interest margin going forward even with higher inventories potentially on balance sheet around quarter-end. For instance, the roughly 100 basis points of financing cost improvement that we mentioned on the investment portfolio could add about $0.02 a quarter to earnings per share going forward from that deal alone. Those are the kinds of things we will continue to focus on to keep net interest margin fairly stable going forward.

I appreciate that color. Lastly, Chris, the business has been extremely strong. Book value has really recovered from post COVID and outlook is positive, whether it’s macro or something specific to jumbo or BPL. What do you view as the biggest risk for the business model in your current ROE outlook as you sit here today?

Good question, Stephen. I think right now the company is executing at a really high level, and so I don’t worry about internal execution as much as external factors. We have a delta variance with COVID, rates were quite volatile in the second quarter, there was a Fed meeting and there is talk about tapering. Those present challenges when you’re running a mortgage pipeline. We proved that we can manage through those, but they do present challenges. There are a lot of competitors entering the space—the BPL market is very attractive. I think we are best of breed, but as we mentioned in our prepared remarks, some are attempting to buy their way in via rate sheets. All of those things are natural evolutions and when you see us and others performing the way we are you expect more competition. But overall, if the economy continues to recover and our businesses execute we are in a very good position. Brook mentioned we released a refined forecast for the second half of the year which I encourage everybody to check out, but right now we’re well positioned.

Great, thanks. Also want to thank you for adding the ESG bullets at the beginning of your press release. That’s helpful and an increasingly important topic.

Thank you.

Thanks, Stephen.

Our next question comes from the line of Kevin Barker with Piper Sandler. Please proceed with your question.

Hello, good afternoon. Could you just talk about what you’re seeing in the residential banking sector and some of the increased competition that you’re referring to and how that compares to the competitive framework you are seeing in the BPL segment?

Maybe we can tag team this one. In residential, the competitive forces aren’t quite the same as in BPL. We got off to a good head start about a year ago post COVID and right now we’re seeing a lot of competition in the securitization markets. Issuance activity is as robust as it’s been probably since the financial crisis, with many issuers, including serial issuers and new entrants, which has put pressure on AAA spreads and particularly pass-throughs. One thing that differentiates us on the residential side is our whole loan distribution, which is very strong. In fact, I think we sold more whole loans in the second quarter than we may have in the history of the company. That distribution has been durable and valuable. On the residential side it’s more a matter of managing the pipeline, managing rate volatility and dealing with tapering and things that impact not only mortgage pricing but also our hedges. That’s an ongoing battle in the mortgage business, but it’s something where we’re very capable and experienced.

On BPL, it’s a slightly different landscape, as always the case with CoreVest. On every loan we do we compete, but it’s a different set of competitors depending on the loan type. As the market has heated up, more equity capital has come into the space and we’ve seen a lot of smaller lenders reemerge with a focus on products that have a lower operational barrier to entry than many of the products we focus on. We feel very good about our strategic position from a borrower penetration perspective as well as operationally with our core SFR and bridge products. The smaller balance products and traditional bridge loans backed by a single house or SFRs backed by much smaller portfolios have attracted strong bids in the market, which is a tailwind but also brings in more competition. We can manage this because speed to close, reliability and product flexibility will win the day, and we feel very good about those traits in our business.

Then a follow-up on the residential mortgage side. You lay out a pretty strong argument that the non-agency market should continue to grow, but it seems like lock volumes may be a little softer in the back half of the year versus the first half. Do you expect that slowdown to be transitory before structural growth in the non-agency market from 2022 to 2023?

It’s hard to project quarter-to-quarter in residential, since we have limited visibility into the direction of rates. The macro forces in non-agency are very strong. There’s still a fair amount of refi optionality, but the forecast we provided is not assuming a massive refinance uptick; it’s based on the current mix. The emergence of non-owner occupied securitizations and demand for that product in the private sector can significantly expand the absolute size of the non-agency space. There is also an emphasis on affordability in Washington which could keep opportunities for the private sector meaningful. So, while short-term volumes can be volatile, the long-term trend supports growth in non-agency.

To add, think of non-agency growth as a multi-year view. Certain zip codes and MSAs evolve into non-agency markets as home prices push more demand above conforming limits. That’s a gradual process; purchases have to occur in those markets. So while there are immediate opportunities, the growth trajectory we’re describing is multi-year and powerful in terms of expanding our footprint.

Okay, thank you for taking my question.

Our next question comes from the line of Bose George with KBW. Please proceed with your question.

Hey, good afternoon. First, can you talk about the execution difference between whole loan sales and securitizations on the jumbo loans?

They are pretty close to each other right now, Bose, particularly as the long end of the curve has retraced a bit. When yields were very low in the long end, securitization might have been slightly better given total return. Now that yields have backed off, they are near parity. Execution depends on the curve and timing, but both channels are working well for us.

Okay, great, thanks. Switching to your guidance, on your BPL guidance in the back half of the year it looks like roughly $500 million a quarter, a little below the $527 million you did this quarter. Is that simply the fact that Q2 was a bump up relative to Q1 or how should we think about that?

That is reflective of the fact that BPL originations were up 37% quarter-over-quarter and we are coming off the highest quarter we have seen since the fourth quarter of 2019 for that business. As we set guidance, we want to be grounded in our ability to deliver. The $2 billion of BPL originations for the year would double the business year-over-year. Additional capital coming to the sector and competitive dynamics, coupled with the fact that strategic partnerships and sourcing channels we have are fairly nascent, led us to set a conservative but achievable forecast. New entrants are focused on products we have originated for years; our footprint in the bridge market is growing and we feel confident in our ability to deliver.

Okay, that makes sense. One regulatory question: given the changes at the FHFA, do you think the 7% cap on second and investment properties could change?

We don’t have any inside information. The private sector has picked up that business relatively efficiently so far. Questions about the capacity of private markets to absorb that supply seem manageable at least for a quarter or two, and the private sector has met the challenge. I’m not sure that restrictions like that will be lifted quickly; subsidizing those mortgage rates continues to impact affordability for first-time homebuyers. It’s possible the caps remain in place for some time. We will wait and see how the new Director of the FHFA and the new regime approach these policies.

Okay, great. Thanks.

Our next question comes from the line of Doug Harter with Credit Suisse. Please proceed with your question.

Thanks. I was hoping you could talk about that $2.60 per share of potential book value gains—what is required on the underlying collateral for that to ultimately be recognized? And how should we think about potential timing for that?

Short answer: more of the same. Over the past four quarters we have seen investment fair value changes of over $265 million driven by the same trends needed to realize more of that $300 million: strong credit performance, improved delinquency trends across our RPL and residential portfolios, and elevated prepayment speeds. Those prepayment speeds have been a real tailwind and in some cases have accelerated timing relative to our original models. Fair value changes as a percent of our net accretable discount have run 10% to 20% recently, which may moderate given strong home price appreciation and the elevated prepayments, but continued spread tightening and faster-than-model prepayments would accelerate recognition of the discount. Also, around 66% of those securities have call rights, which can accelerate recognition when exercised.

Alright. Thank you, Brooke.

Our next question comes from the line of Eric Hagen with BTIG. Please proceed with your question.

Hey, thanks. Good afternoon. Lots of capital is being attracted to single-family rental bridge lending and HPA has been significant. Can you talk about the ability to target the same credit profile that CoreVest has historically targeted? Is it getting more challenging given increased competition? And on the CoreVest side, how do you think about locking in more durable financing for the bridge portfolio, particularly through securitization— is there enough critical mass to become a programmatic issuer there potentially?

Thanks, Eric. Whenever competition enters the space, a cohort of lenders tends to focus on easier-to-originate products and sometimes stretch credit standards. We are working hard to stick to our knitting. Our advantage includes the sophistication of the borrowers we serve and the multi-year head start we have built in scale and relationships. We have many borrowers who have been with us for five years plus and that track record matters. We are focused on evolution of credit standards and product structure, balancing what loans are being offered and term versus the loans we traditionally focus on. Regarding financing for bridge, we are always evaluating options. As Brooke referenced, the team made significant progress optimizing the cost of funds in recent months, which drove a roughly 100 basis point blended cost of funds improvement for the investment portfolio. We watch competitor financing and securitization activity closely and will continue to pursue the best structures for CoreVest.

Thanks for the comments.

Our next question comes from the line of Steve Delaney with JMP Securities. Please proceed with your question.

Good afternoon, everyone. I am spending some time looking at your RPL securities today. It looks like about $2 billion of assets with an investment of just under $500 million. Can you comment on how you acquired those securities? Was it open market or were there large structured transactions that put subordinate securities on your books?

Mostly the latter. Freddie Mac over the years has had programs through which they have transferred credit risk on re-performing loans they acquired off securities onto their balance sheet. SLST is the acronym for our two largest RPL investments, which we put on the books in late 2018 and 2019 respectively. These investments have seasoning and the underlying loans are seasoned as well, many being 14 or 15 years old. The attractive piece was the ability to deploy substantial capital in one transaction at attractive returns and with attractive term financing at the top that’s guaranteed by Freddie. That financing is essentially term-funded debt at a very attractive rate, which simplifies financing the book compared to other structures.

Given that attractive term financing, is there any call right angle or play on these RPLs as there is on some of your seasoned deals, or is it more locked up due to structure?

There is some optionality in the structures we entered into, but it’s not as immediate as with Sequoia and CoreVest given the lockout periods and premiums required to call the transactions. It’s a big part of the story—potentially more of a one-to-two-year story depending on how those transactions progress.

Got it. One last question—bank competition. A few years ago banks were very aggressive on prime jumbos. How is that today in terms of their footprint in the marketplace versus you and others?

Bank demand has always been a two-sided coin for us. Banks like Wells and Chase are meaningful competitors, but they are also part of the distribution market. Whole loan sales have been an important channel for us for years. Year-to-date, we’ve sold more whole loans than in any other full calendar year, which shows there is real demand from depositories and other buyers. Banks remain real participants in the market—competitors in certain channels, partners in others—and we manage around that dynamic.

We perform many rate surveys and are aware of where banks price mortgages. We have enough visibility to understand where liquidity lies. The team’s speed in moving risk has enabled us to be more competitive than in the past. We don’t have a deposit base advantage, but we have mitigated that by turning capital faster, processing loans faster and maintaining high service standards. Right now, we are more competitive with banks than we have been historically, but we also view them as clients—so there is a symbiotic element.

Thank you for the comments and congrats on the positioning. We look forward to the second half of the year.

Thank you.

Thanks, Steve.

Our next question comes from the line of Ryan Carr with Jefferies. Please proceed with your question.

Hi, good afternoon and congratulations on the great quarter. First question on the outlook for residential: your guidance at the high end implies a similar run-rate in terms of volumes for the back half of the year. How much of that in your view is refinance? Given where rates are today, would you expect more activity in the third quarter or the fourth quarter? Also, any thoughts on how potential changes to the foreclosure moratorium may impact the balance of the year?

In Q2 about 60% of our locks were purchase. It’s hard to predict exact quarter-to-quarter moves since rates drive a lot of variability, but our forecast is based on the current mix—solid footing in the purchase market. A rally in benchmark rates that sparks refis would be upside to the forecast, but we aren’t depending on that. Regarding the foreclosure moratorium, we are tracking it closely. The market today is materially different than 2008–2009. There is a cohort of borrowers impacted by the moratorium, but given the level of home equity overall, we remain optimistic that, whatever happens, it will be orderly and borrowers can return to performance. We are monitoring it closely.

Thanks. One quick follow-up on increasing wallet share—how are investments in Horizons and technology initiatives driving synergies to increase opportunities across the business?

I’m glad you asked about Horizons. Internally we are very excited—deal flow has been significant. While capital deployed has been modest to date, the network and deal flow have been abundant, particularly in proptech and fintech opportunities. We want Horizons to have a strong connection to our core business so if an investment becomes a stable business, there are opportunities to expand into interesting areas of finance and proptech that could be transformative for our BPL or residential businesses. It’s early days but very much a focus, and there’s a lot happening behind the scenes beyond capital deployment.

Thanks very much and congrats again on a great quarter.

Thank you.

Thank you, Ryan.

Ladies and gentlemen, this concludes today’s Q&A session, and this does end the call. Thank you everyone for your participation. You may disconnect your lines at this time and have a wonderful day.